Towards better infrastructure investment products

EDHEC Infrastructure Institute-Singapore (EDHECinfra) recently conducted an in-depth survey with 184 asset owners, managers and infrastructure specialists globally, to find out what their perceptions and expectations of infrastructure investment are.

The survey asked the respondents (mostly senior executives active in top management or strategic and investment functions) for their views on the definition, characteristics, expected returns and contributions to investment objectives of infrastructure investment, on their interests in emerging markets, as well as their concerns in areas such as valuation methods, reporting accuracy and accumulation of dry powder in infrastructure funds.

The findings reveal strong interest in infrastructure investment by its respondents, with close to 65 per cent of them saying they intend to increase their allocations to infrastructure over the next three to five years.

Growing consensus on the definition of infrastructure investment

This keenness in infrastructure investment is driven by a growing consensus in how infrastructure should be defined, increasingly differentiating it from other asset classes. 80 per cent of survey respondents see private infrastructure as a specific asset class, versus less than half of them who see listed infrastructure as having unique characteristics. This echoes the recent conclusions made by European insurance regulator about infrastructure and Solvency II, defining qualifying infrastructure assets by their contracts or “business models”, instead of industrial sector categories (which does not distinctly differentiate infrastructure from traditional asset classes like stocks and bonds).

Lack of agreement on expected performance

The survey also finds that most respondents perceive infrastructure investment’s unique feature to be either its potential for portfolio diversification or for harvesting risk premia. However, in terms of expected performance, one-third of the respondents believe that infrastructure should be “expensive” (low yielding) while the remaining respondents require higher returns. And although most asset owners and their managers expect relatively high returns, managers systematically report higher expected returns than asset owners.

In addition, expected returns follow a clear pattern determined by the business model (“contracted”, “merchant” or “regulated”) and the lifecycle (“Greenfield” or “Brownfield”) of infrastructure firms, with “Greenfield” merchant infrastructure requiring higher returns than “Brownfield” regulated and contracted infrastructure, for instance.

That infrastructure should be expensive is to be expected if it can deliver long-term, stable cashflows – a valuable characteristic for LDI investors.

Strong interest for emerging markets infrastructure

The survey reveals that more than half of the participating asset owners, which represent approximately USD 8 trillion of global assets under management, are currently invested or want to invest in emerging markets.

Their interests in emerging markets are driven by the higher returns and country risk diversification. Emerging market premia vary for different types of infrastructure projects. For example, investments in emerging “contracted” and “regulated” categories command much higher spreads (above the OECD required returns), particularly at the “Brownfield” stage, highlighting the long-term challenges of emerging markets. On the other hand, emerging market “merchant” risk is perceived to be almost equivalent to OECD merchant risk.

A degree of dissatisfaction with existing investment products

When queried about their views on the classic close-ended private equity infrastructure fund structure, 82% of asset owners surveyed say they are “outdated and not adding value”. Close to half of institutional investors also say they either “do not trust”, or “do not know whether or not trust” the valuations reported by infrastructure managers.

The survey finds the main reasons driving their dissatisfaction are high fee levels and the absence of well-defined investment objectives of the various infrastructure funds and platforms.

Three-quarter of the asset owners surveyed express that they are either concerned or very concerned about the amount of dry powder accumulated in private infrastructure equity and debt mandates and how it might undermine the quality of future investments.

Survey reveals urgent need for infrastructure benchmarks which are currently lacking or inadequate

In conclusion, the survey result reveals a severe information gap, with 94 per cent of respondents declaring that current options to benchmark private infrastructure investments are either “lacking” or “wholly inadequate”, inhibiting their investment decision-making process to some extent.

Most respondents agree that infrastructure investment only make sense as a long-term strategy and that they prefer to invest in privately-held infrastructure debt or equity, compared to public stocks or bonds. All these speak of an urgent need for a clearer market practice to assess private infrastructure investments.

To this point, EDHECinfra has already put forward a roadmap for the creation of infrastructure investment benchmarks, which includes defining infrastructure as an asset class, and collecting private equity and debt cash flow data from infrastructure projects globally. The creation of usable benchmarks is the first step to allow investors to adequately measure their risk-adjusted performances to better understand the potential of these assets. This will eventually lead to the creation of infrastructure products designed to adequately meet long-term investment objectives, which is what respondents understand infrastructure to be best suited for.

The survey was conducted with the support of the Global Infrastructure Hub, an organisation backed by the G20.

About EDHEC

Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 20 business schools. Fully international and directly connected to the business world, EDHEC is a school for business, rather than a business school, where excellence in teaching and research focuses on innovation to stimulate entrepreneurship and creativity. For business from birth and dedicated to business, EDHEC makes entrepreneurs for life, able to remodel or create successful businesses wherever they work.EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses. The School’s teaching philosophy, inspired by its award-winning research activities, focuses on “learning by doing”.